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Armenia’s Government introduces an unfair income tax

August 3, 2010

By Professor Ara Khanjian

About a month ago, the National Assembly decided to privatize the pension system and adopted an extreme version of a private pension model, where 100% of employee pension payments will be allocated to private individual pension accounts.

Along with the pension system, the National Assembly also radically changed the income tax system. The new income tax is extremely unfair for the poor and lower income families, because of two new changes: First “practically” there will be just one income tax rate for everyone and second, there will be no standardized deduction from the income before applying the income tax.

The old existing income tax law allowed the deduction of 30,000 dram for all taxpayers and the amounts above 30,000 dram were subject to two tax rates: for taxable income below 80,000 dram monthly, the tax rate was 10% and for the taxable income above 80,000 the income tax rate was 20%.

The new income tax law that the National Assembly adopted has no deductions and has two very close tax rates: For all income below 120,000 dram the income tax rate is 24.4%, while for income above 120,000 dram the income tax rate is 26%. Clearly there is almost no difference between 24.4% and 26%. The government could claim that technically we have a progressive income tax, but practically we have just one income tax rate, about 25%.

An income tax system without any deductions is extremely unfair, because if someone earns about 40,000 dram monthly, slightly more than $100, then that person has to pay about 25% income tax, which is 10,000 dram. This person has to cut his/her spending on food and other necessities in order to pay the income tax and will suffer significantly. For this reason all over the world, income taxes of almost every country allow the deduction of a certain amount, usually equal to the established poverty line or the income earned annually based on the minimum wage.

If we agree that a tax system without any deduction is highly unjust, then why has Armenia’s government supported such an unfair income tax system? I asked this question to an individual who was familiar with the development of this new income tax law and this was the answer that I received.

Currently a very large number of employees claim that their monthly income is less than 30,000 dram; therefore they evade paying income taxes. In order to reduce this kind of income tax evasion, the government decided to eliminate the 30,000 dram standardized deduction.

This explanation is not convincing, because the government instead of penalizing the poor and the middle class, it could make a serious effort to collect taxes from businesses, companies and rich, powerful families. If the government aggressively tries to collect taxes from large businesses and wealthy families, then the rich will have incentive to declare to the government the amount of wages and salaries that they are paying to the employees, because wages and salaries are considered tax-deductible costs.

In democratic and developed countries it is very difficult for the employees to hide their income and evade paying taxes, because the government makes a serious effort to collect taxes from businesses, who report the incomes of their employees. Therefore the opponents of the new income tax law could argue, that the government instead of adopting an unfair income tax law and imposing a very large tax burden on the lower income families, they should take serious steps to collect income taxes from businesses and rich people.

The second aspect of the new income tax law, that is unfair, are the two tax rates, which are very close to each other, 24.4% and 26%. Practically this is almost a flat income tax system.

A flat tax is considered unfair, because the tax burden on the low income families will be much higher than the burden of the tax on the upper middle class and rich families. It is much more difficult for a family with monthly income of 100,000 dram to pay 24.4% income tax, than for a family with income 500,000 dram to pay 26% income tax, because once again, in order for the family with 100,000 dram income to pay 24.4% income tax, they need to cut spending on necessities, such as food and medical care.

Most economists agree that in order to generate a fair tax system, the burden of the tax should be distributed equally. The burden of the taxes will be distributed more equally through a genuine progressive income tax with noticeably different tax rates, instead of a tax system with just one income tax rate.

I don’t know if there is a country in the world with an income tax system that has no standardized deduction and at the same time has one income tax rate. No democratic country has such an unfair income tax system as the one that Armenia’s government has introduced.

In Armenia capital markets are not developed and the banking sector is not lending enough. The government could contribute to the development of the financial sector by reducing corruption and the hold of the underground economy. This could be done by focusing on the behavior of large businesses and powerful families and prosecuting illegal acts, by promoting open and transparent governance, by requiring accurate accounting, and by fostering an environment where the public increases their bank deposits, businesses barrow more from banks and banks increase their lending.

Instead the government is hoping to stimulate the financial markets by privatizing the pension system, which imposes much greater risks on the majority of the retirees, who are not usually very knowledgeable about the functioning and inherent risks of the financial markets.

Lower income families in Armenia will be the unfortunate victims of these two significant changes of the financial system made by the National Assembly. Privatization of the pension system places undue risks on low income employees and exposes them to the risks of being without adequate amount of income upon retirement.

Eliminating the standardized deduction and having practically a flat tax system places a heavy tax burden on lower income earners who are least able to afford it. Armenia urgently needs political institutions and forces to protect the interests of poor or low income Armenian families.

(Ara Khanjian is a Professor of Economics at Ventura College, California)